German and European Central Bank officials have grown increasingly obstinate in recent months, showing little sympathy for Greece’s appeals for leniency connected with its bailout agreement. It is unclear what the fallout would be if Greece were to impose capital controls and leave the euro, but it seems that Germany and the ECB just don’t care anymore.

Greece’s new left-wing government blinked on Thursday morning in its month-long standoff with its eurozone partners, saying that it would agree to a six-month extension of the expiring bailout agreement at its current terms so that the two sides could have more time to negotiate. It was a typical “kick the can down the road” move we have come to expect from EU officials, something that Greece’s new government promised it wouldn’t do just a couple days earlier.

The markets rallied on the news, with Greek bank stocks shooting up 10% and Greek 10-year bonds yields falling back to the single digits. The so-called “radical” Greek government finally fell in line with the status quo, and that itself was enough for the market to chill out and hobble onward.

But in a shocking turn of events, Germany’s finance ministry rejected the Greek proposal, saying that it amounted to a bridge financing deal that didn’t propose any “substantial” solutions to the problem at hand.

So, what has changed? Did Germany truly expect a real solution to this issue? Or was the finance ministry just pretending to play hardball to save face with the German public? This wouldn’t be the first time for Germany to claim it was calling Greece’s bluff and then fall apart at the end of the day. It has happened pretty much every time Germany has negotiated a bailout deal since the eurozone debt crisis began in 2009.

But this time could be different. A report in German newspaper Frankfurter Allgemeine Zeitung quotes an unnamed central banker from the ECB who believes that the Grexit may now be inevitable. “One gets the impression that the Greeks want to get out [of the euro] and are just looking for a scapegoat,” at this point, the unnamed central banker told the paper.

This comes a couple weeks after the ECB abruptly stopped taking Greek sovereign bonds from Greek banks as collateral for low-cost loans to fund their operations. The ECB had been loaning the banks money and accepting the junk Greek debt at face value even though it was worth a fraction of that amount in the real world, something that, naturally, angered Germany.

The ECB pulled this cheap financing as Greeks were pulling money out of the their banks amid growing fear of a Grexit, when the Greek banks needed the money the most. The Greek banks were forced to turn to their own central bank for cash, which also borrows from the ECB, but at a higher interest rate.

All this has accelerated the run on the Greek banks, forcing the Greek Central Bank to borrow at a frenetic pace from the ECB to make sure they have enough cash on hand to meet demand. But there is a limit to how much the Greek Central Bank can borrow from the ECB, 65 billion euros, and it appears that they just hit the ceiling. The Greeks reportedly asked the ECB to increase their line of credit by 10 billion euros, but the ECB agreed in an emergency meeting overnight that it would only increase it by 3 billion euros.

The ECB knows very well that money buys the Greek banks a week, two weeks tops. The Greek banks won’t need the money if the panic stops, but that won’t happen unless Germany relents and agrees to Greece’s demand for leniency. With Germany saying Nein today just to extend talks without granting any concessions, it is now clear that the whole situation may actually blow up this time.

Greece will then have to make a tough choice. They will either need to accept total defeat and continue on with the terms of the bailout agreement, which would probably result in a Greek default in a few months time, or they can institute capital controls (which would restrict people’s ability to withdraw cash), default on the bailout now, and leave the euro.

Will the Grexit cause the euro to fall apart? Mario Draghi, the head of the ECB, famously promised that he would do “whatever it takes ” to save the euro, so a Grexit may not automatically mean the end of the currency union. He has been preparing for years to counter the backlash that would follow a Grexit, most recently by announcing a multi-billion euro quantitative easing program that could stabilize the bond yields of EU countries if they explode post-Grexit. Will it be enough? No one knows for sure.

For Greece, neither of its option seems acceptable at this point. For some reason, Greeks overwhelmingly want to stay in the euro, which is why the Greek government swallowed its pride and agreed to kick the can down the road. Jeroen Dijsselbloem, the current head of the Euro group negotiations with Greece, called for a fourth “extraordinary” meeting tomorrow of finance ministers to discuss the Greek plan. While Dijsselbloem is somewhat hopeful that a deal can be struck--he said at the last meeting that he wouldn’t call another unless he thought a deal was close--it will be impossible to strike an agreement without German backing, meaning a Grexit could be just around the corner.

]]>http://fortune.com/2015/02/19/germany-greece-euro-zone/feed/0Greek Finance Minister Yanis Varoufakis Attends News Conference With Germany's Finance Minister Wolfgang Schaeublesolster2A stronger U.S. dollar: the winners and losershttp://fortune.com/2015/02/17/a-stronger-u-s-dollar-the-winners-and-losers/
http://fortune.com/2015/02/17/a-stronger-u-s-dollar-the-winners-and-losers/#commentsTue, 17 Feb 2015 16:27:39 +0000http://fortune.com/?p=993114]]>Like most changes, the surging value of the dollar is creating both winners and losers. It is a blessing for American consumers and those of us who would like a spring vacation in Europe. On the other hand, in the future, it could be a bane in the lives of Americans looking for jobs in manufacturing because it causes the price of American exports to go up, and imports to become cheaper.

The stronger greenback is a reflection of the strength of the U.S. economic recovery, but maybe even more so the weakness of the economies of the Eurozone and Japan. In a global economy, it is important to focus on broad trade-weighted measures of the exchange rate that reflect the relative importance of America's trade with other countries.

Thus, the fact that Russia's ruble has lost half its value against the U.S. dollar means little to America's economy since trade with Russia is minimal. It's a different story with the euro and yen, since the U.S. considers Japan and Europe major trading partners. Adjusted for inflation differences, the trade-weighted dollar has risen by 30 % from its low in 2011--about the same increase it saw during the dot com boom of 1995 to 2002, but it remains far below the prior peaks of 1985 and 2002.

The U.S. and China stand out as two countries whose currencies have experienced the largest appreciation. Japan has witnessed the largest depreciation; the value of the yen has dropped about 30% over the past three years, as Prime Minister Shinzo Abe's government aims to rejuvenate Japan's economy. The euro has fallen nearly 20% against the dollar over the past year, but its trade-weighted decline is actually half that or less than 10%, as other trading partners have followed its value down.

Exchange rates are largely determined by basic forces of supply and demand, but their changing values are frustratingly hard to predict, and large fortunes have been won and lost in bets in their future values. To the extent that foreign exchange is desired for the purpose of purchasing the goods and services of other countries, exchange rates will reflect the relative strength of countries' business activity and differences in rates of price inflation, basic determinants of the demand for exports and imports.

With the growing openness of international capital markets, exchange rates have become more reflective of perceived differences in investment opportunities and they are often dominated by developments in financial markets. That change is particularly true in recent years as innovations in monetary policy, such as various versions of large-scale bond purchases known as quantitative easing, reflect a commitment to an accommodative monetary policy stance extending far into the future, which can have strong effects on exchange rates.

Expectations that interest rates will stay low lead to reduced demand for assets denominated in the domestic currency, and as a result, exchange rate depreciation. With the shift away from quantitative easing in the United States, and its expansion in Japan and the Eurozone, the price of the dollar can be expected to rise even further in relative terms.

To date, these large realignments of currency values among the major economies have had surprisingly small effects on trade flows. Substantial increases in the real value of the dollar in the early 1980s and 2000s were both associated with the emergence of large trade deficits, and the subsequent declines moved the trade balance back toward zero. We came to associate a 10% rise in the real exchange rate with a fall in in the trade balance of 1-1 1/2 % of GDP.

The lack of change in the U.S. trade balance might be attributed to a lagging response to what has been a fairly recent turnaround -- the dollar had been declining in value prior to 2012. And, the U.S. trade deficit will be held down in the short-run by the abrupt drop in the price of imported oil.

The failure of Japan to generate a larger improvements in its trade is more puzzling. More than two years have passed since so-called "Abenomics" initiated a sharp yen depreciation, yet the trade balance shows little evidence of change. Economic developments within the eurozone are also disappointing. The European Union needs a realignment of competition among its members - an effective devaluation in the South and relative price appreciation in the North. Yet, with a common exchange rate, improved competitiveness with the rest of the world brings only ever-growing surpluses for Germany, while the peripheral countries continue to struggle.

Ongoing exchange realignments and shifting trade balances could become more divisive in future months now that the European Central Bank has joined the Bank of Japan in a large program of monetary expansion. As lagged effects of the exchange rate changes work through the trading system, the negative effects on U.S. growth will become pronounced and competitive tensions over exchange rate policies will rise.

Barry Bosworth is a senior fellow in Economic Studies at the Brookings Institution.

]]>http://fortune.com/2015/02/17/a-stronger-u-s-dollar-the-winners-and-losers/feed/0U.S. dollar billsnt2192Obama economist: Don’t count on the U.S. for global economic growthhttp://fortune.com/2015/02/10/jason-furman-us-economy/
http://fortune.com/2015/02/10/jason-furman-us-economy/#commentsTue, 10 Feb 2015 18:04:18 +0000http://fortune.com/?p=983105]]>One of President Obama’s top economic advisers says the rest of the world may have too much faith in the U.S. recovery.

“If your economic plan is to count on exports to the U.S. [to produce growth], that’s not a plan that I would support,” said Jason Furman, who heads the President’s Council of Economic Advisers. “What Europe needs is more growth. Clearly, domestic demand needs to pick up.”

Furman was talking on Tuesday morning at a conference put together by The Economist magazine.

The U.S. economy has been improving lately. But some have questioned if the U.S. will be dragged down by the rest of the global economy, which appears to be flatlining. Furman said that he is “quite positive” on the U.S. economy for 2015, though he joked that part of his job is to have that view, and pronounce it at conferences. He said that slower growth overseas will be a “headwind” for the U.S., but he thinks that will be more than offset by lower oil prices. He also said that average monthly mortgage and other debt payments in the U.S. are at their lowest levels in a while and that should help boost consumption.

Nonetheless, Furman said he thought the growth of the U.S. economy would not be strong enough to pull the rest of the world out of its funk. U.S. consumption makes up 70% of the U.S. economy; it’s only 5% of Germany’s economy. While the European Central Bank’s recent announcement that it would buy bonds to bring down interest rates will help the region’s economy, Furman said it won’t be enough. He said that European countries have the resources to spend money to boost their own economies, and that it is something they should consider. Last month, the International Monetary Fund downgraded its growth expectations for France, Germany, and Italy. As a whole, Europe’s economy is expected to expand at a rate of just over 1% this year, and not much more in 2016.

Oliver Blanchard, who is the chief economist at the IMF and was talking on the same panel at The Economist conference, disagreed with Furman. He said it was incorrect to say that Europe was still in austerity mode. Budgets are expanding modestly, or not shrinking. But he said that European leaders should be concerned that markets could react negatively to more fiscal stimulus measures.

Furman disagreed, arguing that leaders often say that bond investors will sell at the first sign of stimulus spending but that the market supports such measures. Fiscal stimulus moves in Japan and elsewhere have not caused bond prices to fall, and interest rates to spike, he said.

“We have to make sure we are not inventing a bogeyman who won’t show up,” said Furman. “We are way past the point in Europe where they should be doing a big fiscal stimulus.”

]]>http://fortune.com/2015/02/10/jason-furman-us-economy/feed/0Jason Furman 2015stephengandelfortuneEuropean markets in carnival mood after ECB’s QE promisehttp://fortune.com/2015/01/23/european-markets-in-carnival-mood-after-ecbs-qe-promise/
http://fortune.com/2015/01/23/european-markets-in-carnival-mood-after-ecbs-qe-promise/#commentsFri, 23 Jan 2015 12:10:24 +0000http://fortune.com/?p=958175]]>Europe’s financial markets were in carnival mood Friday with both stock and bond markets rising across the board in the wake of the European Central Bank’s promise to pump over EUR1 trillion into the system to fight off deflation.

While debate is still raging over whether the ECB’s ‘quantitative easing’ will actually do the Eurozone economy any good, few seem in any doubt that it’s good for asset prices–although one asset, the euro itself, has fallen a massive 4% against the dollar since the announcement.

“Yesterday's program was at the same time bigger, faster and more explicit than what had been promised before and what the market had come to expect,” gushed Deutsche Bank strategist Jim Reid in a note to clients. “This will be a good environment for European equities and European credit whether you like the fundamentals or not or whether you think it makes any difference to the economy longer-term.”

The biggest beneficiaries of the ECB’s largesse, as in the U.S. with the Fed, will be government bonds. They have gone through the roof since ECB President Mario Draghi opened his mouth yesterday, pushing yields to all-time lows (prices and yields move in opposite directions).

Take Spain, which less than three years ago was pushed into a bailout because its banking system had been destroyed by a construction bubble and its government couldn’t afford to bail it out. Despite a jobless rate still above 23%, and despite a clear lead in the polls for one of the region-wide batch of new left-wing parties determined to throw off the shackles of German-led ‘austerity’, the yield on Spain’s benchmark 10-year bond has fallen to 1.30% from 1.55% a day earlier. It had peaked near 7% in 2012.

Or take Germany, where yields are negative for all bonds which mature in less than six years, and where the 10-year bond now yields a record low of 0.38% (from 0.58% 24 hours earlier).

The effect is just as strong on the stock market, where the DJ Euro Stoxx 600 index is up 1.4% at its highest level since 2007. That’s mainly because the ECB’s announcement has pushed the euro to a new 12-year low of $1.1193 against the dollar, which will make Eurozone exports to the U.S. and China–the only major economies with the strength to absorb them–cheaper.

The Draghi effect: the euro has lost over 4% against the dollar in 24 hours

“The safest bet for a positive QE impact seems to be through a weaker euro exchange rate,” said Carsten Brzeski, an analyst with ING Diba in Germany.

But the ECB’s action is also filtering through indirectly into other markets. Gold prices hit a five-month high Thursday on a revival of the feeling that QE is a debasement of so-called ‘fiat money’ created at the whim of central banks. It stands to gain more inflows from conservatively-minded investors in places like Germany, where the public (and most of its mainstream media) are intensely suspicious of QE–not least since the negative yield on safe investments like government bonds makes the zero yield on gold look attractive by comparison. Gold was off a touch from yesterday’s high at $1,295 a troy ounce by lunchtime in Europe though.

]]>http://fortune.com/2015/01/23/european-markets-in-carnival-mood-after-ecbs-qe-promise/feed/0529173403geoffreytsmithDraghieffectWhat you need to know about the ECB’s QE programhttp://fortune.com/2015/01/22/what-you-need-to-know-about-the-ecbs-qe-program/
http://fortune.com/2015/01/22/what-you-need-to-know-about-the-ecbs-qe-program/#commentsThu, 22 Jan 2015 16:39:31 +0000http://fortune.com/?p=956340]]>1. How big is it?

Draghi promised EUR60 billion of asset purchases per month, to continue “at least until September 2016″. As the program will start in March, that’s at least EUR1.14 trillion ($1.3 trillion), although the likelihood is that it will extend after September 2016. This year, it will be EUR600 billion, or just under 6% of Eurozone GDP.

2. What will the ECB be buying?

The new “Expanded Asset Purchase Program” will include the already-ongoing purchases of banks’ covered bonds and asset-backed securities (currently running at about EUR13 billion a month). It’s being expanded to include debt issued by Eurozone governments, as well as by European institutions such as the European Investment Bank and the Eurozone’s first bail-out vehicle, the European Financial Stabilization Facility. It won’t be buying corporate bonds. Purchases will stretch all along the maturity spectrum, from two years to 30 years. (Read more here.)

3. Wow. I thought it was forbidden from doing that?

You, the Bundesbank and most of Germany, buddy. Still, the same E.U. Treaty that prohibits the ECB from financing governments also allows it complete independence in conducting monetary policy. The interpretation of what is allowed and what not has shifted as the threat of deflation has increased.

4. So are the Germans on board? Or will they sabotage it?

Bundesbank President Jens Weidmann will probably, at some stage, complain loudly. He may even accompany the same old coalition of conservative academics and fringe politicians to the courts in an effort to stop it. But Chancellor Angela Merkel, who undercut the Bundesbank the last time the ECB tried anything this radical, had almost certainly been briefed about the program and she didn’t say anything too harsh about it in a speech at Davos Thursday. German exporters will be delighted. The DAX hit an all-time high after the announcement, because the euro’s now at a 12-year low against the dollar.

5. Has the ECB made any concessions to German fears?

A few. Normally, any losses on assets held by the Eurosystem (that’s the Frankfurt-based ECB AND the 19 National Central Banks) is distributed according to its capital structure. But with the new program, the NCBs will bear the risk for most of what they buy, and risks will only be shared regarding the purchases of E.U. institutions, which will account for a mere 12% of the total. Don’t expect the Bundesbank to be loading up on Italian or Portuguese debt.

Not to start with. Of course, there are nooooo special rules for Greece. It’s just that there are, er, certain ‘technical’ limits to the program.

7. Huh?

The ECB won’t buy more than 25% of any bond issue, or 33% of the marketable debt of any issuer. Now, the ECB already owns a ton of Greek government debt from its first, ill-fated bond-buying program in 2010. There’s very little left in bonds in public hands as most of Greece’s debt is now in the form of IMF/EFSF loans. So, the ECB will wait till its Greek debt matures in July before buying any new stuff. In this way, it will be spared the embarrassment of buying Greek debt while the messy process of negotiations between the new Greek government (likely to be led by the radical left-wing Syriza party) and the Eurozone is going on over writing off some of the country’s debts.

8. Isn’t that blackmailing Greece?

Heavens, no! What strange ideas you have sometimes…No, the blackmail– sorry, ‘pressure on the new government’–will come through week-by-week decisions on whether to let Greek banks carry on borrowing from the ECB. That’s less a Sword of Damocles than a nuclear bomb on a hair trigger hanging over Athens.

8. OK, I get it. So – will it work?

Even Draghi said that QE won’t work on its own. It’s a powerful instrument, but it needs the rest of Eurozone policy to be pulling in the same direction for it to have the maximum effect. That means more government spending by those who can afford it (Germany), and more structural reforms to make people employable (Italy, France). The trouble is, that’s the logic that has driven every ECB stimulus action since 2010.

As UBS chairman Axel Weber told Davos yesterday, “If you’re continually buying time and that time isn’t used for reforms, then you have to ask whether more of the same is the best recipe, or whether you should change the medication.” But he might also have said the same about German fiscal policy, which remains as obstinately attached to running a balanced budget as ever.

Wall Street is feeling bullish this morning ahead of the market open as investors digest the European Central Bank's long-anticipated bond-buying program announcement. U.S. futures are higher, while European markets are mixed. Shares in Asia had a muted session.

Today's must-read story is by Fortune's Erin Griffith and Dan Primack. "The Age of Unicorns" looks at the rise of the billion-dollar tech startup.

Here's what else you need to know about today.

1. Europe gets set for quantitative easing.

This morning European Central Bank President Mario Draghi introduced Europe’s first-ever quantitative-easing program, a large-scale buying of government bonds to stimulate the eurozone’s sputtering economy. Together with its existing programs, the ECB will pump 60 billion euros into the euro zone economy from this March until September next year. The strategy follows the recent U.S. program, which was largely considered a success. Many worry the program won’t have the same effect on the eurozone. As a currency union, each nation state still has its own government bonds and politics with which to contend, making central bank policy a much more complicated process.

2. The dollar store battle could finally be over.

Family Dollar shareholders will finally vote on Dollar Tree’s $8.5 billion bid, bringing an end to a nearly year-long battle between three U.S. discount retail chains. Dollar General DG had battled Dollar Tree DLTR to purchase the third rival, even submitting a competing bid that is about $4 a share higher. The reason for preferring the lower bid, which would leave nearly half a billion dollars on the table, is a potential block by the Federal Trade Commission. The group is poised to block a merger between Family Dollar and Dollar General on antitrust grounds, though the discount chain’s tie-up with Dollar Tree doesn’t face the same complications.

3. Earnings, earnings, earnings.

Earnings season continues with a lineup of top companies coming out with earnings today.

This morning, airlines Southwest LUV and United Continental reported results. Investors are interested to know how lower fuel prices may boost airline earnings this year. Delta, which reported its fourth-quarter results earlier this week, expects tumbling oil prices to result in more than $2 billion in savings over 2015.

Pay attention after the close of trading when Starbucks is scheduled to release results. Starbucks’ annual revenue growth was 11% in 2014 despite coffee prices that doubled over the period. Analysts expect the company to post earnings of $1.16 a share on sales of $4.8 billion during its fiscal first quarter as coffee prices have fallen significantly.

4. Disneyland measles outbreak.

Nearly 60 cases of measles have been reported since mid-December, and most of those illnesses have been linked back to the Disney DIS theme park in southern California. Five employees have been confirmed sick, and the infections have spread as far as the Bay Area in the north. California officials are encouraging people to be vaccinated against the highly contagious, airborne disease, and the Orange County school district may ban unvaccinated students who may have been exposed.

5. Bill and Melinda Gates get into banking.

Through their Gates Foundation non-profit, the couple is tackling a new, major issue for low-income countries: banking. In their annual letter posted Wednesday, they laid out the goals for the foundation over this year and predicted that the “lives of people in poor countries will improve faster in the next 15 years than at any other time in history.” Part of that transformation is the growth of mobile banking, which will allow people who don’t have access to traditional banking systems to store money, make deposits and access a full range of financial products from their phones. The Gates Foundation will focus on creating more mobile-money systems that can push this transformation forward.

During a panel discussion at the World Economic Forum in Davos on the eve of the ECB’s QE announcement, Summers threw cold water on what it might do. Summers said that while he was he was “all for” European central bankers buying bonds, he thought we should be less optimistic about what economic benefit it might have.

“Does anyone here really believe that if QE happens, Europe is in hand?” asked Summers. “QE in Europe will be less successful in the U.S.”

The main reason that is the case, Summers said, is that longer-term interest rates, which QE is supposed to drive down to spur economic growth, are already low in Europe. Rates were higher in U.S. when the Federal Reserve first started buying bonds, increasing the potential impact of QE.

Instead, Summers says what Europe really needs is direct stimulus spending by governments. “Europe has to be more creative with its fiscal policy,” said Summers, who has long been an advocate of additional government spending to try to create jobs in the U.S. as well. “We need QE, but it’s not going to do it on its own.”

International Monetary Fund managing director Christine Lagarde, who was on the Davos panel with Summers, said the prospect of QE is already having positive effects. She said a lower euro will help exports and create jobs. “QE in Europe has already worked in anticipation,” said Lagarde. “Look at the currency.”

Not waiting for Mario: the foreign exchange market has already priced in a big move by the ECB.

Summers countered that the drop in the currency has yet to produce a real gain. “That’s why I am worried,” said Summers. “We have already had an impact, and the economic forecast for Europe has not improved.”

The weaker euro hasn’t yet, for example, been able to support business in Italy. New orders to industry fell 1.1% in December and were down 4.1% on the year, well below expectations. However, it has helped to turn around business confidence in Germany, which was badly dented last year by the Ukraine crisis.

The real problem Summers said is that all of Europe seems set on austerity and cutting back government spending at the same time. Summers said that collective belt tightening is going to lead to lower economic growth in Europe.

“It’s like standing up in an audience,” said Summers. “If you do it, you can see better. But if everyone does it at the same time, no one is better off.”

While some economic commentators have been calling for such a program for years, as my colleague Geoffrey Smith points out, there’s plenty of reason to believe the effort won’t work as intended. Opponents of a European QE program argue that it won’t stimulate investment because the continent’s badly damaged banks and slack demand are the primary cause of the problems in Europe, rather than tight credit conditions.

Meanwhile, governments like Germany, which are running balanced budgets, are loathe to spend more to stimulate deeply depressed and indebted countries elsewhere in the Eurozone, an aggressive strategy that many economists deem necessary to jolt the continent back into growth mode.

Economist Martin Feldstein of Harvard University published a paper with the National Bureau of Economics this week that argues for an alternative approach European governments can adopt to stimulate investment. He advocates for a tax credit to businesses that invest in new projects, which can be paid for by an overall increase in the corporate tax rate. Writes Feldstein:

There are many ways that changing tax rules can increase aggregate spending without raising the fiscal deficit. Investment in plant and equipment can be stimulated by a temporary increase in the tax deductible depreciation rate on new investments in plant and equipment or by an enlarged investment tax credit. It would also be possible to reduce the net cost of funds by converting the deduction for business interest to a refundable credit at a higher effective rate. The cost of equity capital could be reduced by allowing deductions for dividends on common stock or preferred equity.

The resulting revenue loss could be balanced by a temporary rise in the corporate tax rate, effectively taxing the return on old capital while stimulating new investment. The necessary rise in the corporate tax rate could be adjusted after seeing the favorable effect of the policy on economic activity and tax revenue.

Feldstein argues that these benefits could be extended to consumers by giving tax breaks to home builders and homebuyers in the form of mortgage interest deductions. Such deductions could be rendered revenue neutral by raising rates on income elsewhere.

Another appealing part of this program is that while it would work better in a coordinated effort between countries, individual countries could enact these programs without approval from the EU government, as these measures would be revenue neutral and not run afoul of EU restrictions on increasing budget deficits.

In November, Singer, who runs the hedge fund Elliott Management, said that that the U.S.’s economic recovery had basically been “faked” by the Federal Reserve’s stimulus efforts. He called the good economic numbers coming out “cooked.”

On Wednesday during a panel discussion at the World Economic Forum in Davos, Switzerland, Singer continued his attack on the Fed’s policies. He said that the Fed’s quantitative easing bond buying program has been the main driver of income inequality and is exacerbating social instability around the world.

“Inequality is a function of the government’s policies,” said Singer. “There is no question that QE is adding to it.”

Singer admitted that while the U.S. has experienced inequality before, but he said that the players involved in the past were different. He argued that the fact that current inequality is being driven by a rise in investment is clear evidence that the Fed is responsible.

New York University Professor Nouriel Roubini, who was also on the panel with Singer, countered that without the Fed’s stimulus, there would probably be a lot more unemployment in the U.S. That would have probably added to inequality as well. “QE may be helping the rich, but the alternative would be much, much worse for the middle and lower class,” said Roubini.

Singer wasn’t the only one to criticize the Fed and central bankers at the World Economic Forum. In fact, one of the stated themes of this year’s conference is how the world ought to deal with the “addiction” and “excessiveness” that has come with central bank stimulus, which is itself a thinly veiled attack on the Fed. “Central bankers seem to only care about what goes on in their country,” said Axel Weber, chairman of the board at UBS, during a different panel discussion. “There needs to be more coordination.”

Still, criticism of the Fed this year seems oddly timed. U.S. economic growth has been among the strongest in the world these days. And the consensus in Davos seems to be that U.S. economic growth will continue in 2015. Based on that, it’s hard to argue that the Fed has been misguided in its efforts to boost the nation’s economy. What’s more, it appears the Fed has convinced other central banks that quantitative easing works. The European Central Bank is expected to soon announce its own large-scale bond buying program.

Little of that appears to have penetrated the conversation at Davos, though. The primary subject of debate during the panel that included Roubini and Singer was whether markets are good at predicting risk. Roubini argued that markets were indeed good at this task, which is surprising given that the economic had argued for years running up to the financial crisis that the housing and the banking systems were in a bubble.

Roubini said that there was a lot of talk last year at Davos about the potential for a war between China and Japan. The market didn’t seem to suggest that would happen, Roubini said, and the market was correct.

Singer argued that any predictive power markets once had has been eroded by the Fed. “I would put ‘market’ in quotes,” said Singer. “You don’t know what the real price is. The market is determined by the Fed.”

]]>http://fortune.com/2015/01/21/federal-reserve-inequality-paul-singer-davos/feed/0Paul Singer Davos 2015stephengandelfortuneECB QE – Sugar rush for the markets or the Eurozone’s salvation?http://fortune.com/2015/01/21/ecb-qe-sugar-rush-for-the-markets-or-the-eurozones-salvation/
http://fortune.com/2015/01/21/ecb-qe-sugar-rush-for-the-markets-or-the-eurozones-salvation/#commentsWed, 21 Jan 2015 17:41:54 +0000http://fortune.com/?p=953708]]>Barring some kind of grotesque twist, the European Central Bank will announce Thursday that it’s going to start buying the bonds of Eurozone governments in large quantities.

That should be good news for for financial markets, which never turn their noses up at the prospect of free money, but there are a number of reasons why ‘quantitative easing’ may not have the same uplifting effect on the Eurozone economy–let alone the global one–as it did in the U.S.

The biggest difference is political and institutional. While QE had the broadest possible support in the U.S., there are huge political objections to it in Germany, the Eurozone’s largest (and healthiest) economy, as well as a handful of other northern European countries. As such, many fear it could do more to split the currency union than bring it together.

In the five years since the Eurozone debt crisis exploded, German opinion hasn’t really moved much beyond the view that QE will only give lazy and cowardly governments elsewhere an excuse not to make the kind of heroic reforms that Germany did 10 years ago.

“The more they (the ECB) do, the bigger the incentive for governments to do less,” complained Axel Weber, the former Bundesbank head who is now chairman of Swiss bank UBS AG UBS, told the World Economic Forum in Davos Wednesday.

Lars Feld, an economic adviser to the German government, meanwhile told the mass daily Bild-Zeitung that “without reforms, France and Italy will just carry on crawling around, with negative consequences for our exports.”

Outside Germany, almost everyone–from the IMF to France to China–see deflation as the more pressing risk. The headline rate of inflation fell to -0.2% in December thanks to collapsing oil prices, and unemployment is still running at 11.5% of the workforce.

“Europe is not growing and is on the brink of deflating,” former Treasury Secretary Larry Summers said Tuesday in a speech in London. Top ECB officials openly admit that cheaper oil is only strengthening the impression that the Eurozone is heading into a destructive spiral.

According to leaked reports, the ECB is trying to mitigate German concerns about ‘stealth bailouts’ of other countries by suggesting that the act of buying the bonds should be devolved to the respective 19 national central banks of the Eurozone, and that they should only buy the bonds of their own governments. That way, if a country such as Italy should ever leave the Eurozone, it will only be the Italian central bank that loses money on its bond holdings.

The trouble with that proposal is that it implicitly encourages the belief that the Eurozone can after all break up–which is exactly the reverse of what the ECB was trying to argue when President Mario Draghi promised in 2012 to do “whatever it takes” to keep it together.

Then there is the unfortunate fact that the ECB itself has been arguing for years that QE will be ineffective in the Eurozone because it’s banks, rather than bond markets, that determine credit conditions for households and businesses in the Eurozone. About three-quarters of total financing for the economy goes through that channel, while a quarter goes through the capital markets. The proportions are roughly reversed in the U.S.

Ironically, the ECB appears to be launching QE just as banks are starting to lend, again after years of sitting in a zombie-like trance, unable to make new loans because they were sitting on billions in undeclared losses on real estate, government bonds and so on. The ECB’s quarterly bank lending survey, released Tuesday, showed that both the supply of and demand for credit are clearly turning up.

That much, at least, is good news. The extra money that the ECB is ready to create will now find some willing takers in the real economy. By contrast, Draghi’s promise in the summer to increase the ECB’s balance sheet by 1 trillion euros has fallen flat because banks were either unable to find solvent borrowers, or just used the money to replace other, shorter, loans they’d taken from the ECB.

Regardless of its actual merits, the impact of QE on the U.S. (and U.K. and Japan) has been as much psychological as real, by giving the impression that the authorities were at least fully committed to stopping deflation. And that psychological impact has depended largely on its presentation–on its ability to shock and awe financial markets into believing the situation was under control.

The ECB tomorrow will have to overcome two other challenges on that front. First, there are already huge expectations factored into financial markets: Deutsche Bank chief executive Anshu Jain told Davos that markets have already priced in EUR500 billion of QE. With the latest leaks suggesting that the main proposal for discussion tomorrow will be for roughly EUR50 billion a month in bond purchases through the end of 2015–a total of EUR600 billion–it will take something really big for the markets not to ‘sell the fact’ having ‘bought the rumor’.

The weight of expectation on the ECB tomorrow: the euro is already at a 10-year low vs. the dollar.

Secondly, the ECB will be making its announcement at a time when when markets’ faith in central banks is starting to waver quite badly. After the chaos sparked by the Swiss National Bank last week, Denmark was panicked into an unscheduled rate cut Tuesday, and Canada cut its interest rates Wednesday while keeping its core forecast for inflation unchanged and raising its growth estimate for next year–“a spectacular loss of nerve,” according to ADM ISI economist Marc Ostwald in London.

“The whole mirage of stability that developed-world central banks have sought to foster in the post-crisis era (is) starting to unravel in a rather disorderly fashion,” Ostwald said. “The ECB’s task tomorrow looks ever more unenviable!”

]]>http://fortune.com/2015/01/21/ecb-qe-sugar-rush-for-the-markets-or-the-eurozones-salvation/feed/0New European Central Bank headquartersgeoffreytsmithEurozone relief as top EU court says ECB’s secret weapon is legalhttp://fortune.com/2015/01/14/eurozone-relief-as-top-eu-court-says-ecbs-secret-weapon-is-legal/
http://fortune.com/2015/01/14/eurozone-relief-as-top-eu-court-says-ecbs-secret-weapon-is-legal/#commentsWed, 14 Jan 2015 12:48:42 +0000http://fortune.com/?p=943700]]>Eurozone leaders breathed a sigh of relief Wednesday as the European Union’s top court indicated that ECB President Mario Draghi’s promise to do “whatever it takes” to save the euro is on solid legal ground.

Cruz Villalon, an advisor to the European Court of Justice, said that the European Central Bank hasn’t exceeded its powers in giving itself the right to buy the bonds of struggling governments in order to stop the Eurozone breaking up.

In doing so, he effectively nixed a complaint brought by disaffected German scholars and investors and backed by many in Germany, including the Deutsche Bundesbank (though not, importantly, by the government in Berlin). Germany’s Constitutional Court had supported the plaintiffs last year, but had referred the case to the ECJ in Luxembourg because of its Europe-wide dimensions.

Villalon’s opinion isn’t binding, but the ECJ generally tends to follow the thinking of its advocate-general. A final ruling is expected around the middle of this year.

It was the ECB’s “Outright Monetary Transactions” program, outlined by Draghi in 2012, that turned Eurozone bond markets out of a destructive spiral that threatened to push countries as big as Spain and Italy out of the currency union in 2012.

Italy’s 10-year borrowing costs had soared to over 7% as investors feared that they would be repaid in a reintroduced and sharply-devalued lira rather than in euros. The measure of how much the markets trusted Draghi’s promise is that, as of today, Italy’s 10-year bonds yield only 1.72%–despite the fact that its debt burden has risen after another two years of virtually no growth.

Source: Tradingeconomics.com

Villalon added only a couple of minor provisos to his opinion, saying that the ECB mustn’t take any part in devising bailout programs for Eurozone nations in future, and adding that the program must still leave room for the market to set a representative price for a government’s bonds.

But he rejected conditions that the German Constitutional Court had said it wanted to be attached to the ECB’s actions, such as imposing “ex ante” limits on the amount it could buy, and insuring that the ECB got repaid ahead of other investors if a country subsequently defaulted.

“The Eurozone's rescue shield stays strong, making it unlikely that it will ever actually have to be used,” Berenberg Bank analyst Christian Schulz wrote in a note to clients.

“The risk of deflation is still low, but it is certainly bigger than a year ago,” Draghi said.

]]>http://fortune.com/2015/01/14/eurozone-relief-as-top-eu-court-says-ecbs-secret-weapon-is-legal/feed/0ECB President Mario Draghi Rates ConferencegeoffreytsmithECB’s €500 billion QE plan pushes euro to new 9-year lowhttp://fortune.com/2015/01/09/ecbs-e500-billion-qe-plan-pushes-euro-to-new-9-year-low/
http://fortune.com/2015/01/09/ecbs-e500-billion-qe-plan-pushes-euro-to-new-9-year-low/#commentsFri, 09 Jan 2015 14:12:21 +0000http://fortune.com/?p=937084]]>The euro fell briefly below the level where it first traded against the dollar 16 years ago, as reports leaked out confirming that the European Central Bank is considering a large-scale program of government bond-buying.

By lunchtime in Europe, the euro was trading close to yet another new nine-year low at $1.1791. After a tricky first couple of years in which it struggled to win the confidence of international markets, the single currency has never traded below its opening level of $1.1789 on Jan 4, 1999.

Look out below – the euro against the dollar, since its creation in 1999. Source: ECB

Bloomberg reported earlier that ECB governors had considered a plan at a council meeting Thursday under which it would buy up to EUR500 billion of government bonds in an effort to stimulate the Eurozone economy by pushing down long-term interest rates, the way the Federal Reserve, Bank of England and Bank of Japan have over recent years.

The council is likely to take some kind of decision in two weeks’ time, when it next meets.

The report had a relatively muted effect on financial markets, as the EUR500 billion number was at the low end of the range of market guesses (it’s barely any more than the Bank of England bought to support an economy a quarter the size of the Eurozone’s).

Speculation on “ECB QE” that has become increasingly intense since the start of the year. The Eurozone’s headline annual rate of inflation turned negative for the first time in over five years in December, and even though that was mainly due to the sharp fall in global oil prices-something outside the Eurozone’s control–it added to fears that the region is sliding into a deflationary spiral.

The December CPI number may not in itself represent deflation, but the Eurozone still seems too weak to recover without further action of some sort: industrial output in both France and Germany worsened again in November, according to figures released Friday.

ECB President Mario Draghi reiterated in a letter to European lawmakers Tuesday that the bank is considering additional measures to stop the Eurozone falling into such a spiral, saying that: “Such measures may entail the purchase of a variety of assets - one of which could be sovereign bonds.” He’s been making that point since a speech in late November.

There’s more than just a little irony in this. The ECB has actually spent the last six years explaining why such ‘quantitative easing’ projects wouldn’t work in the Eurozone. It has masked the real reason–the fear of offending Germany by buying up the debts of weaker sovereigns like Italy–with arguments of varying conviction.

The strongest of these, advanced repeatedly by Draghi himself, has been that banks, rather than markets, are the biggest source of finance to Eurozone businesses, and an ECB bond-buying binge won’t change the fact that many banks haven’t got enough capital to risk making new loans. (Even a bank like Banco Santander SA SAN, which sailed through last year’s stress tests, still found it necessary to raise EUR7.5 billion in a capital increase Friday).

One interesting angle of the Bloomberg report was that the ECB only considered buying ‘investment grade’ government bonds. That would exclude those of Greece and Cyprus, which are both rated junk by all the major ratings agencies. As such, the plan insulates the ECB from the risk of default by a new left-wing government in Greece, something that should in theory make it easier for noted hawks like the Deutsche Bundesbank’s Jens Weidmann to agree to the plan.

The ECB’s next policy-setting council meeting is set for Jan. 22.–three days before Greece’s parliamentary elections.

Learn more about the ECB from Fortune’s video team:

]]>http://fortune.com/2015/01/09/ecbs-e500-billion-qe-plan-pushes-euro-to-new-9-year-low/feed/0ECB President Mario Draghi Rates ConferencegeoffreytsmithLook out below - the euro against the dollar, since its creation in 1999. Source: ECB Dissent, deflation, delay – 5 things to know about today’s ECB meetinghttp://fortune.com/2014/12/04/dissent-deflation-delay-5-things-to-know-about-todays-ecb-meeting/
http://fortune.com/2014/12/04/dissent-deflation-delay-5-things-to-know-about-todays-ecb-meeting/#commentsThu, 04 Dec 2014 17:13:15 +0000http://fortune.com/?p=891366]]>The European Central Bank sat on its hands again Thursday at its last meeting of 2014, unsurprisingly in view of the fact that its official interest rates are already “at the lower bound”, as the economists say (0.1% for the key refinancing rate, -0.15% for the deposit rate). Rates being a dead letter, the discussion at President Mario Draghi’s press conference naturally revolved around why the ECB didn’t expand its bond purchasing programs, and how it sees the sharp drop in oil prices playing out in the Eurozone. Here’s what we learned.

1. There is trouble brewing over Quantitative Easing. That’s a problem because, with rates already effectively at zero, the only way the E.C.B. can support the economy more is by buying bonds and driving down interest rates. Draghi and a “big majority” of the council say they “intend” to expand the E.C.B.’s balance sheet by around 50% to EUR3 trillion, roughly where it was three years ago. But he admitted there was no unanimity on that “intention” (which in E.C.B.-inside-baseball-speak is firmer than an “expectation” but not as firm as a “target”). At least the two Germans on the 23-person council–and probably allies like board member Yves Mersch–oppose that language. That means internal arguments will check Draghi’s impulse to do more…

2. …even as further stimulus becomes more and more necessary. The E.C.B. sharply cut its growth forecasts for this year and 2015-16. It now sees G.D.P. rising only 1% in 2015 and 1.6% in 2016 (from estimates of 1.6% and 1.9%, respectively in September). It also said it will miss its medium-term inflation target of just under 2% by more than expected. Inflation is now seen at 0.7% next year and 1.3% in 2016. That’s not exactly deflation, but it’s too low. With nominal rates at zero and the inflation rate falling, “real” interest rates (adjusted for inflation) are rising. As Draghi said – that’s not what the E.C.B. wants at all.

3. The new forecasts don’t even include the collapse in oil prices since last week! The cut-off date was Nov. 13, well before the Organization of Petroleum Exporting Countries pulled the rug out from under the oil market. Prices have fallen another $10 a barrel since then. But don’t expect the E.C.B. to react to a dip in headline CPI because of oil effects: Draghi was clear that the fall is “unambiguously positive” for the Eurozone, as lower fuel prices leave consumers more disposable income. But he’s afraid that employers will use that development to justify giving lower pay rises, which would drive the CPI even lower, and that’s a no-no.

4. The fiscal cavalry isn’t coming. Draghi has pleaded since the summer for those countries that can afford it (i.e. Germany) to use fiscal policy to stimulate the economy. Unfortunately, Germany is too proud of running a balanced budget this year to oblige him, and economists are in any case doubtful of how much that would actually do to bring about much more pressing growth-friendly reform in countries such as France and Italy. The E.U., which has a minimal budget of its own, unveiled a plan earlier this week that it hoped would stimulate EUR300 billion of investment in infrastructure and the like. It’s been dismissed as wildly optimistic, but as Draghi wistfully observed, “It’s the only instrument we have” on the fiscal side.

5. Things will come to a head early in 2015. The E.C.B. does its best to leave at least three months between its major policy actions. It knows that the effects of monetary policy on the real economy take time (as opposed to the the immediate sugar-rush it gives financial markets). “Just like it took the Titanic time to turn,” you might say, but that’s what all the research confirms. The doves on the council will need at least another month to convince the hawks of the need to break that last taboo and buy government bonds in large scale. They might have to wait for the next set of official forecasts in March make their argument irresistible. Draghi said they don’t have to wait for unanimity to make that decision, but pressing ahead without German support risks a whole new existential row over the future of the euro, maybe even lawsuits in Germany’s constitutional court supported by the Bundesbank and, in short, a whole new iteration of the euro crisis.

]]>http://fortune.com/2014/12/04/dissent-deflation-delay-5-things-to-know-about-todays-ecb-meeting/feed/0New European Central Bank headquartersgeoffreytsmithThe Fed’s loose money policy is risky, unfair, and essentialhttp://fortune.com/2014/11/13/federal-reserve-quantitative-easing-policy/
http://fortune.com/2014/11/13/federal-reserve-quantitative-easing-policy/#commentsThu, 13 Nov 2014 12:54:04 +0000http://fortune.com/?p=858553]]>At least for now, quantitative easing--the central-bank practice of creating large sums of money to purchase financial assets--is no more in the U.S.: At the end of October the Federal Reserve announced it was switching off the gusher. (A day later, Japan announced it was moving in the opposite direction.)
In many quarters, the response was one of relief. Since the Fed opened for business a century ago, it has seldom, if ever, carried out a more controversial policy.

Many conservatives regard QE as a misguided attempt to subvert the currency that will inevitably lead to an inflationary spiral, a speculative bubble, or both. From the left, and even from some establishment voices, comes the charge that QE is a means of enriching the 1% and accentuating inequality. (One former Fed official described it as "the greatest backdoor Wall Street bailout of all time.") Meanwhile, there are economists who question QE on a more basic level: It doesn't work, they insist.

It's easy to see where the critics are coming from. In the past six years the Fed's balance sheet has expanded by $3.5 trillion, a figure that has a whiff of the Weimar Republic about it. And because QE has helped raise asset prices, the beneficiaries are those who own a lot of stocks and real estate: i.e., the rich. The poorest 50% of U.S. households, who possess just 1% of the country's wealth (yes, it's that low), haven't seen much gain from QE.

But despite all this, the critics are wrong. QE is potentially dangerous, and it's unfair. In certain circumstances, though, it's essential. After a financial crisis, such as the one we saw in 2008, it can be used to prop up the banking system and help restore normal intermediation. And in a slow-growing economy where the central bank has already reduced interest rates as much as it can and where worries about the deficit rule out fiscal stimulus, QE is one of the few tools that can be used to prevent the economy from descending into a semipermanent deflationary slump--the kind of one that Japan has endured for the past 20 years.

Back in 2008-09, the Fed used QE1 to head off the risk of a Great Depression-type outcome. In 2012, when QE3 was enacted, the danger was less acute: We had slow GDP growth, high unemployment, and a low rate of inflation. Since then growth, after stalling last year, has picked up. And the jobless rate has fallen from 8.1% to 5.9%--a big improvement.

ASSET BUBBLE? In late 2008 the Fed started buying back financial instruments to keep interest rates low. About a year later the U.S. stock market took off.Graphic Source: S&P Capital IQ

To be sure, we don't know precisely how much of this can be attributed to QE. However, we do know that without QE things would have been worse. Studies suggest it reduced long-term bond yields by one or two percentage points, which translated into lower rates on mortgages and other consumer loans. QE also helped the Fed devalue the dollar, a boon to U.S. exports. It also signaled that America is serious about preventing a repeat of the Japanese deflationary experience. U.S. inflation, excluding volatile food and energy items, has stabilized at about 1.7%.

Even today, though, the threat of deflation is bigger than the threat of inflation. That's why some believe QE was withdrawn prematurely. (At October's Fed meeting, Narayana Kocherlakota, the president of the Federal Reserve Bank of Minneapolis, dissented from his colleagues' decision.) History provides some support for the doves' concern: Twice in the past five years the Fed has turned off the spigot, only to be forced to reverse course when the economy sputtered.

Right now, GDP growth and job creation look pretty solid. That's the justification Janet Yellen and her colleagues cited for halting their asset purchases, and I don't doubt their word. But I suspect they also had another motivation that wasn't publicized. If the economic weakness in Europe and Asia spreads to the U.S. next year, the Fed will need to respond, and QE is about the only weapon left in the armory. Rather than expend all its firepower now, it decided to keep some in reserve.

John Cassidy is a Fortune contributor and a New Yorker staff writer.

This story is from the December 1, 2014 issue of Fortune.

]]>http://fortune.com/2014/11/13/federal-reserve-quantitative-easing-policy/feed/0Finance Icon Thumbnailclyons2014ASSET BUBBLE? In late 2008 the Fed started buying back financial instruments to keep interest rates low. About a year later the U.S. stock market took off.Japan’s latest economic stimulus exposes its dirty debt secrethttp://fortune.com/2014/10/31/japan-monetary-stimulus-debt/
http://fortune.com/2014/10/31/japan-monetary-stimulus-debt/#commentsFri, 31 Oct 2014 16:00:19 +0000http://fortune.com/?p=845458]]>The surprisingly aggressive monetary move made by the Bank of Japan (BOJ) overnight may look like a winner today, but it could easily backfire down the road if the government isn't careful.

The BOJ is again buying trillions of Yen worth of government bonds in an effort to expand the money supply and stimulate exports. But the government isn't stopping at that this time. It is also pushing the nation's largest buyer of government bonds, the Government Pension and Investment Fund of Japan (GPIF), to invest more of its cash in Japanese equities, instead of in safer government bonds.

While this all seems like a great way to pump up the markets and create some sort of wealth effect among Japan’s tight-fisted population, it also risks exposing the nation’s dirty little secret--its horrendously large government debt load. With the GPIF no longer funding the Japanese government's lavish spending, who will?

The Japanese stock market rallied 5% on Friday to its highest level since 2007 following the BOJ announcement. While the markets had expected the BOJ to continue buying government bonds as part of its long-running effort to stimulate the economy, the amount targeted, some 80 trillion Yen, was larger than expected. But that isn't what pushed equity markets to a seven-year high. The driver here was GPIF’s move into Japanese equities.

GPIF will start ratcheting down the proportion of its portfolio allocated toward Japanese government debt to 35% from 60% and increase its holdings of domestic equities to 25% from 12%, creating a huge dislocation in the Japanese financial system. GPIF will also increase its holdings in foreign equities to 25% from 12% and its holdings of foreign bonds to 15% from 11%. The equity and debt markets in Europe and the U.S. should also benefit from this new buyer in the market, which helps explain Friday’s rally on Wall Street.

Nomura estimates that the GPIF and smaller public pension funds will need to offload some 20 trillion Yen ($180 billion) worth of Japanese government debt to make this happen. That may be a conservative estimate but it is probably the best one out there. In any case, who will buy all this debt? Well, the Bank of Japan, of course, as part of its stimulus program to weaken the Yen. So it all works out perfectly, right? The best answer right now is, maybe.

Japan's Prime Minister Shinz? Abe hopes this move will finally dislodge the nation’s stalled economy. The weakened Yen will pump up exports, driving up corporate profits while also encouraging consumer spending due to inflation. With the GPIF realignment, Abe is probably hoping the accompanying increase in the equity markets will induce a Japanese-style "wealth effect" in which the population feels richer and thus begins to spend money like rock stars or some weird Hello Kitty character on a candy binge.

Abe's bond-buying program is similar to the Federal Reserve's "quantitative easing" (QE) stimulus program, which ended this week after a multi-year run. In buying government bonds and keeping interest rates low, the Fed was able to force investors to dial up the risk in their portfolios, thus helping to spur the economy out of recession and into expansion. But QE hasn't worked as well in Japan because, unlike the Fed, the BOJ was also fighting deflation. So investors in Japan didn't have to face the prospect of seeing their money lose value if they just let it sit in the bank as their fellow savers in the U.S. did. Coupled with the fact that Japanese investors are usually more risk-averse compared to their Western counterparts, so this didn't fare well for Abe's plans.

Which brings us to today's announcement. By essentially forcing Japan's largest investor to give up on bonds and buy equities instead, Abe is hoping that it will spur other Japanese investors to do the same. He is also hoping that the bond buying he plans to do will be enough to push real interest rates below zero for an extended period of time, forcing even the most risk-averse Japanese investors to look elsewhere to park their cash. Abe also hopes those investors will either shift into Japanese equities or simply liquidate and buy up those Sony TVs that the once-mighty electronics retailer can't seem to get foreigners to buy anymore.

What are the chances this will work? Prodding the GPIF to buy equities may indeed stimulate the stock market in the short term, but it is unclear that it will spur the type of risk-taking needed in the long term to really dislodge Japan's stalled economy for good. The wealth effect Abe is trying to stir up using stocks may not take off in the same way it has occurred in the U.S. Japanese companies simply aren't doing as well as U.S. companies, so it will be harder for them to extend this rally as far as it occurred in America. So Friday’s pop may be all there is.

Even more concerning is how all of this change will affect Japan's debt markets. By shifting the GPIF's focus away from buying bonds, the Japanese government is essentially telling its most important customer of its debt to go spend its money elsewhere. That means Japan needs to find another buyer to fund its debt load, which it can't. Instead, Japan is having the BOJ essentially print a bunch of Yen. This doesn't seem sustainable.

The Yen is not the world's reserve currency, the U.S. dollar is. So there isn't a huge international demand for Japan's debt. The BOJ can't print money indefinitely like the Fed and get away with it. Eventually, there will be consequences. Japan's national debt of $11 trillion is nearly 240% of its GDP, the highest proportion of debt to GDP for any sovereign nation in the world by a wide margin. It has easily funded this debt load thanks to investments made by its massive pension funds, which the government is now cajoling to move its money elsewhere.

There is no telling how long the BOJ can keep funding the government's debt without causing a real financial meltdown. The pendulum may swing quickly from fears of deflation to hyperinflation, which would undoubtedly upset Japan's population, as their hard-earned savings would suddenly be worth nothing. Japan's government would see their debt burden fall but would have to pay through the nose to service any future bond payments.

This doomsday scenario isn’t on the minds of Japanese politicians; they just want some growth now. But it was the same sort of short-sided thinking that induced Abe's predecessors to run up huge deficits; it was to stimulate growth, growth that never came. If growth fails to come this time, Japan's number may be up.

]]>http://fortune.com/2014/10/31/japan-monetary-stimulus-debt/feed/0shinzo abe japansolster2As the Fed leaves the QE party, Japan tops up the punchbowlhttp://fortune.com/2014/10/31/as-the-fed-leaves-the-qe-party-japan-tops-up-the-punchbowl/
http://fortune.com/2014/10/31/as-the-fed-leaves-the-qe-party-japan-tops-up-the-punchbowl/#commentsFri, 31 Oct 2014 09:27:54 +0000http://fortune.com/?p=844812]]>The Bank of Japan stunned financial markets Friday, announcing an increase to its monetary stimulus program in a fresh effort to revive an economy that has labored since a big tax hike in April/May.

The move underlines the sharp divergence in fortunes between two of the world’s biggest economies. It comes only two days after the Federal Reserve confirmed the end of its five-year program of ‘quantitative easing’ , against the background of an economic recovery that appears increasingly sustainable. The economy grew at an annual pace of 3.5% in the third quarter, according to data released Thursday.

The dollar surged to its highest level against the yen in over six years in response to the move, while the benchmark Nikkei 225 index soared nearly 5% in the belief that a cheaper yen would benefit Japan’s big exporters. Stock markets across Asia and Europe also rose sharply, as the news tamed growing fears of a return to deflation in the world’s third-largest economy.

The Bank of Japan said it will increase the pace of its purchases of Japanese government bonds, stocks and real estate funds so that base money supply increases at an annual level of 80 trillion yen ($730 billion), up from a level of 60-70 trillion yen that it has targeted since unveiling a big new stimulus program a year and a half ago.

Curiously, the Bank didn’t seem too concerned about the state of the Japanese economy, saying that it expects it to continue growing faster than its medium-term trend. However, it said it wanted to ensure that Japan kicked its “deflationary mindset”, which has reasserted itself in recent months as oil prices have slumped and as demand has weakened in the wake of a 5% increase in value added tax in the spring.

Tom Kenny, an economist with ANZ Bank, said the decision may well be a sign that the government will rethink its plans for another, bigger increase in VAT next year.

Data released earlier Friday had given a clear sign of what the BoJ was afraid of. Headline inflation ran at an annual rate of 3% in September, but the underlying increase in prices (excluding the effect of the VAT hike) was only 1%–half of the 2% rate the BoJ wants to achieve. Household spending has also faltered, and was down 5.6% in the year to September, below expectations of a 4.3% drop.

The BoJ’s decision was a surprise to the market because BoJ governor Haruhiko Kuroda had repeatedly said he thought Japan would meet its inflation target. The decision was taken by the narrowest of margins, with a 5-4 split in favor.

]]>http://fortune.com/2014/10/31/as-the-fed-leaves-the-qe-party-japan-tops-up-the-punchbowl/feed/097215349geoffreytsmithAre we really saying goodbye to QE forever?http://fortune.com/2014/10/29/federal-reserve-quantitative-easing/
http://fortune.com/2014/10/29/federal-reserve-quantitative-easing/#commentsWed, 29 Oct 2014 13:20:25 +0000http://fortune.com/?p=839879]]>At long last, it’s here: On Wednesday, the Federal Reserve is expected to announce the end of its stimulative bond-buying program, known as quantitative easing.

Or at least that’s what a lot of headlines will read. Technically, the program won’t be ending because the Federal Reserve will still keep on its books the trillions of dollars of longer-term government debt and mortgage bonds that it has bought since the first round of QE in 2008. And the Federal Reserve argues that keeping these bonds off the market will continue to have stimulative effects.

Federal Reserve officials have made it clear that its cessation of bond buying hinges on the continuing improvement of the U.S. economy. If things get worse, the Fed assures us, they won’t hesitate to start bond buying once again. But the conventional wisdom is that, even if the economy isn’t a strong as we’d like, it’s strong enough to no longer need the Fed to continue to pile on support, and that we’re beginning the process of returning to something that looks more like pre-crisis Fed policy.

It would be nice if market participants could actually agree on what all these years of bond buying has done for the economy. But they can’t. So it’s not surprise that why no one can agree on what the end of QE will actually mean for the markets or the economy.

Take, for instance, the disconnect between the Federal Reserve’s own predictions for inflation and the future path of interest rates and what the bond markets think will happen. As Jim O’Sullivan, chief U.S. economist at High Frequency Economics, points out in a recent note to clients, the bond market is predicting that inflation will continue to fall below the Fed’s goals and that interest rates will be 150 basis points below what the Fed is hoping for by the end of 2015.

O’Sullivan thinks that the difference can be summed as a disagreement between the Fed and the bond market over how well the economy will be doing a year from now. The Fed is more optimistic than the bond market when it comes to employment and inflation, and something, eventually “will have to give,” he writes. “We expect bond yields to rise as market expectations for Fed policy adjust.” Even a scenario in which the Fed ends up “lowering their projections somewhat,” Sullivan argues, “would entail higher bond yields.”

But others point out that the Fed has been consistently overoptimistic in recent years, so why should we expect anything different next year? Jim Bianco, president of Bianco Research, points to recent comments by St. Louis Federal Reserve Bank President James Bullard that declining inflation expectations suggest that the central bank should hold off ending QE altogether. Bullard’s about-face on QE, which just a few months ago he was certain would end this fall, is evidence of the Fed’s unmerited optimism. As Bianco said last week in a conference call with clients:

I have argued and will continue to argue that the Fed is going to get out of QE on the October 28th meeting. They're going to taper $15 billion and they're done. If you ask the Fed whether they are done with QE forever, they will tell you, "Yes." If you put them under truth serum and ask them that, they would still tell you, "Yes." As was the case after QE1 and after QE2, they were dead serious--"We're done. This experiment is done forever."

Then, we had a 17% correction in stocks after QE1 ended and the Fed freaked out and gave us more money printing to stop it (QE2). When QE2 ended stocks had a 20% correction and again the Fed freaked out and gave us Operation Twist. This eventually morphed into more money printing.

In other words, the Fed said it was done before, but that’s only because it was too optimistic about the future health of the economy. So the central bank may end QE tomorrow, but the chances that the Fed will rev up its bond-buying machine in the near future are significant.

Bianco believes the main goal of QE is to prop up the stock market with the hope that an expensive stock market will give people the confidence to spend. Fed officials would probably argue that higher asset prices are merely a second-order effect of their policy and that they are primarily trying to lower interest rates in an effort to get businesses to invest. But either way, the policy requires growth in demand to organically materialize within the economy so that there are people and firms willing to invest at these new low interest rates.

And it’s this last part that really hasn’t come to fruition. Job gains continue to accelerate, but wage growth is flat. Economic growth in 2014 might end up a tick above last year, but it’s still far below what you would normally see in a recovery. To believe Wednesday will truly mark the beginning of the end of Fed stimulus, you’d have to believe that we are in the beginning stages of a legitimately robust recovery. There’s some evidence to support this notion, but don’t expect the jury to return with a decision anytime soon.

]]>http://fortune.com/2014/10/29/federal-reserve-quantitative-easing/feed/0Fed Chair Janet Yellen Holds News Conference Following FOMC MeetingchristopherrmatthewsWhy the Fed should raise interest rates soonhttp://fortune.com/2014/10/08/federal-reserve-interest-rates-2/
http://fortune.com/2014/10/08/federal-reserve-interest-rates-2/#commentsWed, 08 Oct 2014 17:02:52 +0000http://fortune.com/?p=813675]]>The jobs report last week brought plenty of good news. The economy added 248,000 jobs in September, beating expectations; unemployment ticked down from 6.1% to 5.9%. The August jobs numbers were also revised upwards from 142,000 to 180,000, and the private sector has added 10.3 million new jobs over 55 months of job growth, according to The New York Times.

Some countervailing factors still prevail. The labor force participation rate has been steadily declining over the past decade and dipped again in September to 62.7%, suggesting that even though unemployment is declining, there are still plenty of people in the background who have simply stopped looking for work. The other big concern is that wage levels are not rising, putting a damper on financial prosperity even for the people who manage to find jobs.

The Federal Reserve, which has indicated before that it would consider raising interest rates once the job market improves, is now at a crucial crossroads in this process and needs to decide which aspects of America's economy will have greater impact on the future and should determine interest rates. Despite the conventional wisdom that the Fed should keep rates low well into next year to avoid derailing the recovery, waiting too long would be a serious mistake.

For one thing, the Fed can't really influence wage levels. It's true that cheap money makes it easier for companies to pay higher wages, but even that money must eventually be repaid and can also be put to other uses - such as developing new products, which can boost a company's profits and be preferable from a long-term view. In addition, wages are based on supply and demand, and the supply of labor could outpace demand for some time due to a slower growing economy. Put another way, a rise in interest rates could certainly lead to a drop in new hiring or expansion plans, but static interest rates aren't likely to spur wage growth.

The other, and more compelling, reason for the Fed to reconsider its wait-and-see strategy is that low interest rates can lead to a disastrous asset bubble. In fact, the Fed has expressed concern about the formation of a bubble in high-risk leveraged loans after banks ignored industry guidelines, and is stepping up its scrutiny of the $800 billion arena. The problem, as a report from Bloomberg points out, is that no matter how diligent Fed Chair Janet Yellen's team is about identifying risks, it can't rein in an overheated market that can make handsome profits from trading. In a hyper-low interest rate environment, asset bubbles are inevitable, uncontrollable, and most importantly, can build up fast.

The Fed should, then, weigh the risks posed by an overheated market on the economic recovery in the future, and consider that any benefits accruing to workers today may well be reversed by the rapid decline in asset prices, tightening of credit, spillover effect on corporate profits, and subsequently on wages, hiring, and consumer spending when the bubble bursts. A certain amount of fiscal discipline is required to ensure that the hard-won economic gains of the past few years are preserved for many years, and that requires increasing interest rates sooner rather than later.

There are signs that the Fed gets this, saying in its last policy meeting that it will scale back its bond-buying program from $85 billion a month to $15 billion a month in October to reduce the artificial stimulus to the economy. However, it also indicated that it has no timeline for reduction of its benchmark short-term interest rate and that it expects the rate to remain at zero for a "considerable time". Forecasts indicate that the rate could reach between 1% and 2% by the end of 2015, which means a very slow uptick and one that is unlikely to cool down overheated markets after it's priced in.

When the Fed releases the minutes of its last policy meeting on Wednesday, market watchers will assess the Fed's likely direction and bet accordingly, but that is also part of the problem. Instead of forcing investors to read between the lines, which only encourages more market speculation, Yellen should get out ahead of the process and lay out a clear-cut strategy and timeline that will keep the markets stable and growing gradually. When it comes to the economic impact of Fed guidance, decisiveness is key.

Given the overall healthy state of our economy now, the fear of a downturn caused by higher interest rates is overblown and needs to be balanced against the very real danger of new asset bubbles forming that can reverse our progress if they burst.

Sanjay Sanghoee is a political and business commentator. He has worked at investment banks Lazard Freres and Dresdner Kleinwort Wasserstein, as well as at hedge fund Ramius. Sanghoee sits on the Board of Davidson Media Group, a mid-market radio station operator. He has an MBA from Columbia Business School and is also the author of two thriller novels. Follow him @sanghoee.

]]>http://fortune.com/2014/10/08/federal-reserve-interest-rates-2/feed/0Federal Reserve Lowers Key Rate By Three Quarters Of A Pointsolster2To get Europe off its economic rut, give its people cashhttp://fortune.com/2014/09/04/to-get-europe-out-of-its-economic-rut-give-its-people-cash/
http://fortune.com/2014/09/04/to-get-europe-out-of-its-economic-rut-give-its-people-cash/#commentsThu, 04 Sep 2014 19:03:39 +0000http://fortune.com/?p=781487]]>The U.S. economy is recovering from the Great Recession, but Europe remains in bad shape. Much of the continent is flirting with deflation, and yet the European Central Bank's solution is to try to force over-indebted households and firms to borrow more. The latest example: On Thursday, the central bank cut borrowing rates further and announced a new stimulus plan that involves buying financial assets. The move comes as the eurozone has barely grown during the past year, even though interest rates are in negative territory.

So why do all this when the underlying problem is simply that Europeans are not spending enough?

The core problem is that central banks are using 19th century tools to solve 21st century problems. When central banks were first formed, governments charged them with providing liquidity to banks in order to prevent bank runs and with financing the government bond market. To do this they either controlled the interest rate or swapped assets for cash.

They still have those tools today, and not much else. It's time we gave them a new tool: the ability to bypass the financial sector and give cash directly to households.

Direct cash transfers boosts spending and does not discriminate against borrowers or savers, which is the case with manipulating interest rates. It also allows individuals to decide what to do with their money. Some spend it. Some invest it. Some use it to repay debt (a good thing, particularly if debt is holding back growth). Some may just save it, but even that helps banks rebuild their balance sheets and lend more without going through the convoluted mechanics of quantitative easing and the like.

Not only is this far preferable to central banks attempting to force borrowers and savers to act against their wishes, but all empirical evidence suggests that cash rebates boost spending far more effectively than roundabout policies such as large-scale bond purchases and infrastructure spending. Taking the effects of the 2008 economic stimulus as a guide suggests that transferring less than 5% of GDP to households would create a recovery in the eurozone stronger than the recovery generated by the 20% of GDP involved in quantitative easing globally since 2008.

To be clear, politicians should not have this tool at their disposal. The role of politicians would be limited to legislating this tool and determining the rules governing distribution. Thereafter politicians would have nothing to do with the policy. Central banks would remain independent and would adhere to their inflation targets. They would simply be given a new tool to fulfill their mandates. When faced with recession or deflation, central banks can transfer an amount they deem appropriate directly to households. The bank decides when and how much to transfer. When its inflation target is reached, it stops the policy. Period. Yet, if this policy is so simple and studies have shown it is effective, why has it not been tried?

One reason is turf battles. When the ex-governor of the Bank of England Mervyn King was asked about cash transfers he dismissed it as 'fiscal policy,' and not the job of the central bank, a sentiment the governor of the Bank of Japan echoed earlier this year. But this is semantics: monetary policy is whatever we ask the central bank to do. If we grant it the power to make payments to households, it becomes monetary policy.

Others object that so-called 'money-printing' and inflation are synonymous. This is not the case: all schools of economics agree that inflation depends how much is printed, and under what conditions. With direct cash transfers, central banks would print a fraction of what they would have to do with quantitative easing, and they would transfer funds only if they believe it would help meet medium-term inflation-targets--targets that the ECB, for example, is missing month after month with current policy. If cash transfers can revive demand and create self-sustaining recoveries, central banks can then normalise interest rates, cutting off inflation at the root, but only after a real recovery has taken hold.

Far from proposing something revolutionary, all we are advocating is better plumbing and a more efficient use of existing resources. We have asked central banks to solve problems that they were never meant to address. It is only fair that we give them the tools to do the job we ask of them.

Mark Blyth is a professor at Brown University and the author of Austerity: The History of a Dangerous Idea. Eric Lonergan is a hedge fund manager living in London and the author of Money. This piece is based off their article Print Less but Transfer More in the September/October issue of Foreign Affairs magazine.

]]>http://fortune.com/2014/09/04/to-get-europe-out-of-its-economic-rut-give-its-people-cash/feed/0454602156nt2192The end of the era of decisive central bankshttp://fortune.com/2014/08/22/the-end-of-the-era-of-decisive-central-banks/
http://fortune.com/2014/08/22/the-end-of-the-era-of-decisive-central-banks/#commentsFri, 22 Aug 2014 19:03:28 +0000http://fortune.com/?p=775162]]>Legend has it that when President Harry Truman grew tired of the indecisiveness of his economic advisers, he begged for a one-handed economist who wouldn’t analyze every policy proposal with “one the one hand . . . but on the other.”

For a few moments during the financial crisis and subsequent recovery, it looked like former Federal Reserve Chair Ben Bernanke would be that one-handed economist. His decisive and bold action to stabalize global financial markets during the worst of the crisis earned him Time Magazine’sperson of the year award. And his decision to implement a program of open-ended bond buying in order to lower long-term interest rates and spur hiring in 2012 has helped bring the unemployment rate down from around 8% to it’s 6.2% level today.

But despite the fact that the job market remains far from healthy, Ben Bernanke began last year to wind down the Federal Reserve efforts to keep interest rates low by moving to end the central bank’s program of bond buying. Newly ascendant Fed Chair Janet Yellen has taken up this mantle, and in her speech at the Federal Reserve Bank of Kansas City’s annual symposium in Jackson Hole, Wyoming, Yellen doubled down on the idea that the time for extraordinary central bank action, and one-handed economists, is over.

Yellen’s speech, entitled “Labor Market Dynamics and Monetary Policy,” focused on how we should judge the health of the labor market in an era when, because of changes in the economy and society, the unemployment rate is a less reliable indicator of labor market health. Though the unemployment rate has fallen pretty dramatically, the high rate of long-term unemployment, part-time work, and slow wage growth is evidence that the labor market isn’t nearly as healthy as it could be. But Yellen’s speech was filled with qualifications as to why, despite the fact she believes the labor market to be much too weak, she is hesitant to move the Fed from what appears to be an autopilot path toward ending its long-term bond buying program and the eventual raising of interest rates sometime next year.

Meanwhile, the other big-wig at the Jackson Hole conference, Mario Draghi, spent time in his speech outlining the absolute disaster the European economy has been over the past seven years. But beyond some of the small-bore measures the central bank announced in June it was taking to fight disinflation and sky-high Eurozone unemployment — now running at around 11.5% — Draghi unveiled no new policies. He did, however, lay blame at the feet of national European governments for not enacting fiscal policies and supply-side reforms that would help boost growth.

Draghi is certainly correct that there’s much the national governments of European countries could do to help boost growth, and it’s likely true that he is being prevented from taking stronger action, like initiating a quantitative easing program of its own. But when faced with the human suffering that has been allowed to continue because of inaction from European governments, it’s at the very least galling to hear the ECB head talk up the mini-measures he’s undertaking and ignore the fact that EU policies and politics preventing bolder action are causing real harm.

The fact that the Federal Reserve is beginning to retreat from the oversized role it played in our economy is music to the ears of many. Lots of folks long for a time of more “normal” markets that weren’t so reliant on the actions of the central bank. But there’s plenty of reason to believe changes in our economy, from the the aging of our society to growing income inequality, call for a greater role for central banks and the federal government, not less. Reverting to the ways of the past simply for the sake of doing so, rather than for what’s best for the greater good, is no way to govern. Whether it’s from national governments or technocrats at the central bank, we need bolder action, not a wishing away of the real problems our economies face.